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Why Cisco Became a Great Buy After a Terrible Quarter

Learn why Cisco Systems could be a strong buy after the company' poor guidance and top line performance caused a market sell-off last week.

After missing the Street's revenue consensus by a wide margin, Cisco Systems(NASDAQ:CSCO) plunged 11% last week. However, although the company's top-line results and weak guidance were disappointing, Cisco's operating profit came in above the forecast, and operating cash flow remains solid.

The results are proof of an industry that's changing rapidly. Competitors such as Juniper Networks(NYSE:JNPR) are enjoying strong demand for software-defined networking, or SDN, which do not rely on specialized hardware. Competitors in the security segment, like Palo Alto Networks(NYSE:PANW), are capturing market share by delivering innovative solutions such as “next-generation firewalls.” At the same time, there's a new tech paradigm in the making, the “Internet of everything,” which could bring big business opportunities, as it attempts to give all kinds of objects, from cars to railroads, the ability to connect to the Internet.

Source: Cisco Investor Relations

Adapting to a changing industryOverall, Cisco remains well-positioned in key markets, such as data networking, switching, and routing solutions. The company's network certification remains the industry standard. More importantly, management keeps focused on new markets, like the Internet of everything.

Although Cisco has a well-diversified product portfolio, its most important revenue source is clearly the switches and routers business, which accounts for nearly two-thirds of the company's product revenue. This is because Cisco's proprietary hardware is the backbone of hundreds of corporate networks.

The SDN threatSince they are hardware-independent, SDN solutions are a real threat to Cisco's dominant position in the network industry. Juniper Networks is particularly hard to beat, because the company is using a licensing business model that prioritizes software over hardware. Apart from being cheaper, Juniper's SDN solutions make networks more programmable and personalized. As a result, the company has grown its revenue for five consecutive years, reporting $1.19 billion in revenue for the third quarter of 2013.

Security solutions is a promising marketThe good news is that although SDN solutions are a real threat to Cisco's ability to cross-sell its hardware, an innovative culture and a constant search of new business opportunities could help to offset any adverse effect on revenue. In particular, increasing demand for security is an attractive growth catalyst, as the global market for network security is expected to reach $13.4 billion by 2016.

Cisco's security business unit currently accounts for only 3% of total revenues. However, the company has been investing heavily in this segment. For example, it bought cyber security firm Sourcefire this year, which specializes in network security and advanced malware protection.

Palo Alto Networks -- which provides next-generation firewalls that enforce security policy based on applications, content, and users -- is a strong competitor in this field. Founded by several high-level employees of Juniper Networks, the company has experienced an amazing revenue growth rate of more than 8,000 percent from 2008 to 2012. Its product is said to be a game changer, since traditional fireworks are being challenged by complex cyber techniques, such as port-hopping and tunneling.

The Internet of everythingCisco's main growth catalyst is the Internet of everything, which is set to increase the global demand for networks, routers and sensors. The company is an early mover, as it is investing in developing low-cost, low-power sensors, that can be programmed to share information over the Internet.

Foolish bottom lineAlthough Cisco experienced a tough quarter, it remains well-positioned in key markets, such as routing. Surely, the company faces strong competitors in every segment, from security to switching. However, cash flow remains solid and management is committed to finding new markets, such as security and the Internet of everything. Last week's market sell-off could actually be a great buying opportunity for patient investors.

Author

Worked as an engineer and IT consultant for 25 years. Internet entrepreneur since 1996. Webmaster of Beautifulperu.com, Investometrica.com, Inmobiliariadelperu.com, among other sites and apps. Fool since 2013. In love with tech, innovation, startups, marketing, researching emerging markets, and taking a Foolish approach to business model analysis.